Energy Transfer (ET -0.22%) is a popular income-generating investment. It has garnered so much favor among income-seeking investors because it pays a lucrative 7.4%-yielding distribution that it has been steadily increasing each quarter.
Investors who like Energy Transfer might want to check out fellow master limited partnership (MLP) Plains All American Pipeline (PAA 0.63%). The oil pipeline company has a higher-yielding payout (9.1%) that it has been growing faster than Energy Transfer's distribution.
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A well-oiled, cash-producing machine
Plains All American Pipeline owns an extensive pipeline network that transports 8 million barrels of oil and natural gas liquids (NGLs) across the U.S. and Canada each day. It also operates other related infrastructure like terminals, NGL fractionation facilities, and storage assets, and has a leading marketing operation. These assets generate fairly stable cash flow, as long-term contracts support about 80% of its earnings (less than the 90% fee-based earnings level of Energy Transfer).
The MLP generated enough cash to cover its lofty distribution by a comfy 1.7 times during the first quarter (lower than Energy Transfer's 2x coverage ratio in the period). It uses the cash it retains to invest in high-return capital projects and make bolt-on acquisitions.
Plains All American Pipeline also has a rock-solid balance sheet. It ended the first quarter with a 3.3x leverage ratio, which was toward the low end of its 3.25x-3.75x target range. The MLP has a lower leverage level than Energy Transfer, which ended the first quarter with its leverage ratio near the low end of its 4.0x-4.5x target range. Energy Transfer is more comfortable with a higher leverage level due to its steadier earnings profile and more diversified business.
One major factor differentiating Plains All American Pipeline from Energy Transfer is its ownership structure. Plains All American, like Energy Transfer, is an MLP that sends its investors a Schedule K-1 federal tax form each year. However, it also offers investors the option of owning shares of Plains GP Holdings (PAGP 0.56%), which sends a 1099 form.
That entity is a better option for investors who don't want the complications of dealing with a Schedule K-1 each year. It's also better for those who want to hold shares in a retirement account like an IRA. Plains GP Holdings has a 25% interest in Plains All American Pipeline. It provides investors with a slightly lower yet still very lucrative dividend yield of 8.6%.
More income, now and in the future
Plains All American has a higher current yield and offers investors more income growth potential. The MLP has grown its payout at a 21% compound annual rate over the past four years. This year, it gave investors a $0.25-per-unit raise to $1.52 per unit (nearly 20%). It aims to grow its payout by around $0.15 per unit each year (roughly 10% annually from its current level) until it reaches a coverage ratio of 160% (coverage will be around 175% this year). That's much faster than the 3% to 5% distribution growth rate targeted by Energy Transfer.
The oil pipeline company is investing its excess free cash flow to expand its operations. It currently expects to invest $300 million to $400 million annually on organic growth capital projects, like extensions and expansions of its existing assets. For example, the company placed the 30,000-barrel-per-day Fort Saskatchewan fractionation debottleneck project into service in the first quarter, enhancing its fee-based cash flow in Canada. The company's growth capital investments help supply it with additional income that it can use to grow its distribution in the future.
Plains All American Pipeline will use any remaining excess free cash flow and its balance sheet flexibility to make bolt-on acquisitions as opportunities arise. For example, it bought the remaining 50% interest in Cheyenne Pipeline in the first quarter, enhancing its integration. It also acquired Black Knight Midstream's Permian Basin crude oil gathering business for $55 million. Deals like these also supply the company with incremental income that it can use to help grow the distribution.
Higher income potential
Energy Transfer is a great option for investors seeking to generate passive income because it pays a lucrative and steadily rising distribution, backed by a rock-solid financial profile. Plains All American Pipeline offers an even more enticing income stream. While it has a bit more variability in its cash flow, it has a very strong financial profile. That's enabling it to grow its distribution at a faster rate. It also offers an option for investors who want to earn a lucrative income stream without receiving a K-1 (Plains GP Holdings).
These features make Plains an enticing option for those seeking a higher-octane income stream.
